Chapter 19:Consumer Choice

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

13e

19-2

Consumer Choice• Prices are important in determining

consumer behavior. – New products have to be priced correctly. The

price could be set too high and suppress sales – or too low and suppress profits.

19-3

Learning Objectives

• 19-01. Know why demand curves are downward-sloping.

• 19-02. Know the nature and source of consumer surplus.

• 19-03. Know the meaning and use of price discrimination.

• 19-04. Know how consumers maximize utility.

19-4

Determinants of Demand

• Sociopsychiatric theories tell us why people desire certain goods and services, but do not tell us why they are actually purchased.– To buy goods, one must be both willing and able

to pay for them.– Prices and income are just as relevant to

consumption decisions as are basic desires and preferences.

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Determinants of Demand

• Four factors determine an individual’s demand for a product:– Tastes (a desire for this and other goods).– Income (of the consumer).– Expectations (for income, prices, tastes).– Other goods (their availability and prices).

19-6

Utility Theory• The more pleasure (satisfaction, utility) we get

from a product, the higher the price we’re willing to pay for it.– Utility: the pleasure or satisfaction obtained from

using a good or service.– Total utility: the amount of satisfaction obtained

from the consumption of a series of products.– Marginal utility: the change in total utility obtained

by consuming one additional (marginal) unit of a product.

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Diminishing Marginal Utility

• Law of diminishing marginal utility: the marginal utility of a good declines as more of it is consumed over a given time period.– The pleasure received from the next slice of

pizza, say, is less than the pleasure received from the previous slice.

• Eventually, additional quantities of a good yield smaller increments of satisfaction.

19-8

Diminishing Marginal Utility

As long as marginal utility > 0, total utility increases. When marginal utility becomes negative, total utility maxes out and then decreases.

19-9

Price and Quantity• The more marginal utility a product delivers,

the more we are willing to pay for it, and vice versa.

• As marginal utility diminishes, we buy additional quantities only if the price decreases.

• The law of demand states that the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus.

19-10

Price and Quantity• The demand curve

slopes downward because of diminishing marginal utility.

• In order to justify buying more, the price must be lower.

• At $0.25, the consumer buys 12 ounces (point f).

19-11

Market Demand

• Market demand is the sum of all our individual demands for a product.– Its characteristics are the same as the

individual’s demand curve, except that the numbers are much larger.

– It expresses the collective willingness and ability to pay, not just that of one person.

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Consumer Surplus

• Consumer surplus: the difference between the maximum price one is willing to pay and the price actually paid.

19-13

Consumer Surplus

• A person high up on the demand curve is willing to pay a lot for a good.

• A person down low on the demand curve is not willing to pay very much for a good.

• The demand curve represents what each potential buyer is willing to pay for a good.

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Consumer Surplus

• The market price is what each will actually pay (or not pay).– If a person’s maximum price exceeds the market

price, he or she will buy and accumulate consumer surplus.• He or she may consider it to be a bargain!

– If a person’s maximum price is less than the market price, he or she will not buy and will gain no consumer surplus.• He or she may just not think the good is worth the price.

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Price Discrimination

• If a seller could charge the maximum price each potential customer is willing to pay, then total revenues (the price of a good times the quantity sold in a given time period) would go up and consumer surplus would go to zero.

• Price discrimination: the sale of an individual good at different prices to different consumers.

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Price Discrimination

• The technique behind price discrimination is “divide and conquer.”– Separate the customers and deal with them

individually. Discover their maximum prices and make the deal at that price.

– This technique works best when consumers do not have perfect information and when consumers make only occasional purchases.

19-17

Choosing among Products• Shopping trips usually entail selecting from

several goods.• The goal is the same: to get as much

satisfaction (utility) as possible from our available income.

• To do this, rational behavior requires buyers to compare the anticipated utility of each good with its price. That is, make the marginal utility to price comparison (MU/P).

19-18

Choosing among Products• All MU/P ratios must be greater than 1 to be

considered.• Then rank order the choices according to

MU/P. Choose the highest one first, then the next, etc. Remember, for successive units of a good, MU decreases.

• Keep doing this until all of the next MU/P ratios are equal and you are indifferent to choosing among them. At this point, you have maximized your utility.

19-19

Utility Maximization Rule

• Choose according to MU/P ratio, taking the highest first, then the next, etc.

• Do this until all of the next MU/P ratios are the same.

• You will have optimum consumption: you maximized the utility received for the money you spent.

Utility-maximizing rule: MUx = Muy

Px Py